The ASP Effect on the Software Industry

The Internet model of servers accessed by simple browsers is turning the business software industry inside out. Existing application vendors are working out new business and licensing practices so they can offer their software as Net-based services, for which customers pay a monthly fee instead of a more or less one-time licensing fee.

At the same time, startups are introducing applications designed from the ground up as hosted application services and pricing them accordingly. Some of these firms are emerging as rivals to traditional financial or accounting software vendors. But others are minting their software, such as collaboration and electronic marketplace tools, especially for the Internet.

The reason that both old and new vendors are targeting this market is clear: An increasingly big chunk of application sales is expected to come from hosted services in years to come. Forrester Research, for instance, says that about one-fifth of total applications revenue will come from hosted services by 2003.

Established software vendors are attempting to play in the hosted applications market in a variety of ways. Some, such as Lawson Software Inc. of St. Paul, Minn., are refocusing sales to ASPs themselves, which in turn will market the software to businesses targeted by geography, industry or size. Baan Business Systems is taking a similar approach, but the company only sells its software to ASPs that are trained to Baan's "Level 1" support criteria.

Other software makers, such as J.D. Edwards & Co. and Oracle Corp., are becoming ASPs. Both companies contract with service providers to host servers that run their software. But both software firms handle all customer interactions: marketing, sales and support.

J.D. Edwards launched its application service, dubbed Jde.source, earlier this month. The company pays MCI WorldCom's UUNet subsidiary to run and maintain a pack of Sun Solaris servers and to maintain the network. But J.D. Edwards handles all the support of its OneWorld software suites and sells the service to customers through its own sales force. Today, users can access OneWorld through a downloaded software program, while a complete Web version is scheduled for release around midyear.

Not only will the established vendors face off against one another as ASPs, but they will also need to stave off start-ups building applications designed from the start to run in a hosted environment.

One such newcomer is Intact, a Cupertino, Calif., firm that will launch a hosted business accounting application. Intact will rely on service provider Verio for its data center needs. Intact founder David Thomas, who launched a timesharing accounting software company in the 1970s, says established vendors are just as new to the ASP market as last week's start-up.

"They start at the same place as everyone else. And they don't know the Internet," he says.

The traditional software players see it differently.

"Customers have a business problem, and it takes intellectual property to solve it," says Jim Whorley, general manager of global outsourcing for Baan, which has U.S. headquarters in Herndon, Va. "Startups cannot come up with the kind of intellectual property that Baan, SAP or other vendors have created over years.

It's naive to suggest otherwise."

In one sense, both companies are right. The vendors' intellectual property, manifested in the code of applications such as SAP's R/3, is a formidable asset. But the Internet changes the way in which those assets have to be deployed, in that companies are able to integrate their business processes with those of business partners more so than ever before.

Forrester Research analysts predict traditional business applications, such as enterprise resource planning programs, will not even be the main drivers for hosted services. Rather, applications written from the ground up for e-business transactions are expected to become the leading hosted programs.

One challenge for the established vendors is that their applications were designed to be used by individual companies, not shared among many. That adds to the work that needs to be done to roll out an application service to each new customer. "Companies like SAP and PeopleSoft will find it hard to make the systems and organizational changes needed to make true network-based applications," says Laurie Orlov, a research director at Forrester.

Pricing is also an issue. Oracle and J.D. Edwards have constructed their services so there's no adverse revenue effect on their sales staffs. In Oracle's case, customers decide to buy the Oracle Applications suite, then decide whether to use - and pay extra for - a hosted service.

Forrester's Orlov argues this is "old world" pricing - customers rent for the same cost as buying, and have nothing at the end of the rental period. What's needed, and Forrester analysts predict will arrive in the next year, is "subscription-based" pricing, which works more like a lease. For a given period, business customers will pay a per-user monthly fee that includes license, implementation and service. At the end of the term, they can buy or renew their lease.

Going forward, businesses moving into e-commerce will make more as well as more urgent demands on software vendors and service providers that will force further changes by the software vendors and ASPs.

Some customers will look for new Web-based applications that will let companies collaborate more easily. Others will demand groups of integrated applications from different vendors. Others will want hosted services such as electronic marketplaces that enable companies to manage procurement or other processes.

Established and new software vendors, on their own or with service providers, will have to show they have the in-house expertise and the business partnerships to meet these demands.

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